LOYAL3 SECURITIES, INC.

Transcription

1 STATEMENT OF FINANCIAL CONDITION JUNE 30, 2016 UNAUDITED

2 The accompanying notes are an integral part of this financial statement. 2

3 1. Description of Business LOYAL3 SECURITIES, INC. NOTES TO FINANCIAL STATEMENT LOYAL3 Securities, Inc. ( L3Securities or the Company ) is a Massachusetts corporation, which was originally incorporated in 1972 as Merrimack Valley Investments, Inc. and changed its name to LOYAL3 Securities, Inc. in November 2012 after it was acquired by LOYAL3 Holdings, Inc. ( L3Holdings or the Parent ). L3Holdings is a holding company that owns 100% of the equity of L3Securities. L3Holdings is a Delaware corporation incorporated on November 26, The Company s corporate office is located in San Francisco, CA. L3Securities operates as a self-clearing broker-dealer. The Company executes its transactions through Apex Clearing Corporation on an omnibus basis. The Company s customers may engage in securities transactions without incurring any commissions or other fees and can acquire fractional shares in individual stocks, with a certain minimum amount of investment. L3Securities provides retail investors the ability to participate in initial offerings of securities and allows issuers to create affinity award programs featuring company stock as a reward ( Stock Rewards TM offerings). L3Securities is a registered broker under the Securities Exchange Act of 1934 and is a member of the Financial Industry Regulatory Authority ( FINRA ) and Securities Investor Protection Corporation ( SIPC ). 2. Going Concern Through June 30, 2016, the Company had accumulated a deficit of $29,644,000. During the six months ended June 30, 2016 the Company satisfied most of its working capital needs through capital contributions from the Parent, and such contributions are expected to be necessary through the course of the fiscal year. These facts raise substantial doubt as to the Company s ability to continue as a going concern. The financial statement has been prepared assuming the Company will continue on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business and does not include any adjustments that might result from uncertainty about the Company s ability to continue as a going concern. Management s plan to alleviate the going-concern uncertainty includes, but is not limited to, continued expense reductions, expansion of new product offerings and continuing to seek working capital funding from its Parent. The Company s continued existence is also dependent upon its ability to increase revenues generated from operations, which would enable the Company to achieve a profitable level of operations. 3

4 2. Going Concern (continued) LOYAL3 SECURITIES, INC. If anticipated operating results are not achieved, management has the intent, and believes it has the ability, to further delay or reduce expenditures. In such case, the further reduction in operating expenses will need to be substantial. Failure to generate sufficient cash flows from operations, raise additional capital, or reduce certain discretionary spending would have a material adverse effect on the Company s ability to achieve its intended business objectives. The Company can give no assurance that it will be successful in its plans and can give no assurance that additional capital will be available at all. Should the Company not be successful in obtaining the necessary capital to fund its operations, the Company would need to curtail certain or all of its operational activities and/or contemplate the sale of its assets if necessary. 3. Summary of Significant Accounting Policies Presentation For the purpose of presentation, except for the tables in Notes 6 and 7, dollar amounts displayed in these notes to financial statement are rounded to the nearest thousand. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with original maturities of ninety days or less to be cash equivalents. Cash Segregated for Regulatory Purposes The Company is subject to Rule 15c3-3 under the Securities Exchange Act of 1934, which requires it to maintain cash or qualified securities in a segregated reserve account for the exclusive benefit of its customers. In accordance with Rule 15c3-3, the Company had portions of its cash segregated for the exclusive benefit of its customers at June 30, Restricted Cash Restricted cash as of June 30, 2016 included cash on deposit with the Company s clearing organizations. 4

5 3. Summary of Significant Accounting Policies (continued) Marketable Securities Marketable securities in the statement of financial condition consist of financial instruments carried at fair value with related unrealized gains or losses recognized in the statement of operations. Marketable securities are those that can readily be sold, either through a stock exchange or through a direct sales arrangement. Fair Value of Financial Instruments Substantially all of the Company s financial instruments are recorded at fair value or contract amounts that approximate fair value. The carrying amounts of the Company s financial instruments, which include cash and cash equivalents, cash segregated for regulatory purposes, and restricted cash, approximate their fair values. Fair Value Measurement Definition and Hierarchy The Company follows the provisions of Accounting Standards Codification ( ASC ) 820, Fair Value Measurement and Disclosures, for its financial assets and liabilities. Under ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the exit price ) in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters, or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments complexity. Assets and liabilities recorded at fair value in the statement of financial condition are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by ASC 820 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows: Where available, fair value is based on observable market prices or parameters, or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments complexity. Assets and liabilities recorded at fair value in the statement of financial condition are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by ASC 820 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows: 5

6 3. Summary of Significant Accounting Policies (continued) Fair Value Measurement Definition and Hierarchy (continued) Level 1 Unadjusted, quoted prices are available in active markets for identical assets or liabilities at the measurement date. The types of assets and liabilities carried at Level 1 fair value generally are G-7 government and agency securities, equities listed in active markets, investments in publicly traded mutual funds with quoted market prices and listed derivatives. Level 2 Pricing inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument s anticipated life. Fair valued assets generally included in this category are stock warrants for which market-based implied volatilities are available, and unregistered common stock. Level 3 Pricing inputs are both significant to the fair value measurement and unobservable. These inputs generally reflect management s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Fair valued assets generally included in this category are stock warrants for which market-based implied volatilities are not available. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement falls in its entirety is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Accounts Receivable Accounts receivable are recorded at the invoiced amounts. To the extent deemed necessary, the Company maintains an allowance for estimated losses from the inability of clients to make required payments. The collectability of outstanding invoices is continually assessed. In estimating the allowance for doubtful accounts, the Company considers factors such as historical collections, a client s current creditworthiness, age of the receivable balance and general economic conditions that may affect a client s ability to pay. The Company believes that no allowance for doubtful accounts was necessary as of June 30,

7 3. Summary of Significant Accounting Policies (continued) Equipment and Fixtures Equipment and fixtures are reported at historical cost, net of accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over useful lives of three to five years. Leasehold improvements are amortized using the straightline method over the lesser of the life of the lease or the service lives of the improvements. Maintenance and repairs are charged to expenses as incurred; costs of major additions and betterments that extend the useful lives of the assets are capitalized. When assets are retired or otherwise disposed of, the costs and related accumulated depreciation or amortization are removed from the accounts and any gain or loss on disposal is recognized. Contingent Liabilities Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company, but which will only be resolved when one or more future events occur or fail to occur. The Company assesses such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company, or un-asserted claims that may result in such proceedings, the Company evaluates the perceived merits of any legal proceedings or un-asserted claims, as well as the perceived merits of the amount of relief sought or expected to be sought therein. If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company s financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability and an estimate of the range of possible losses, if determinable and material, would be disclosed. Loss contingencies considered remote are generally not disclosed, unless they involve guarantees, in which case the guarantees would be disclosed. There can be no assurance that such matters will not materially and adversely affect the Company s business, financial position, and results of operations or cash flows. Income Taxes The Company accounts for income taxes under the provisions of ASC 740 Income Taxes. ASC 740 requires the recognition of deferred tax assets and liabilities for both the expected impact of differences between the financial statements and tax basis of assets and liabilities and the expected future tax benefit to be derived from tax loss and tax credit carryforwards. ASC 740 additionally requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. 7

8 3. Summary of Significant Accounting Policies (continued) Income Taxes (continued) The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are determined based on temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect in the year in which temporary differences are expected to reverse. A valuation allowance is recorded to reduce deferred tax assets to an amount whose realization is more likely than not. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations in the period that includes the enactment date. Subsequent Events The Company has evaluated all subsequent events up to the date this financial statement was issued. Adoption of New Accounting Pronouncements In August 2014, the Financial Accounting Standards Board ( FASB ) issued a new accounting standard which requires management to evaluate whether there is substantial doubt about an entity s ability to continue as a going concern for each annual and interim reporting period. If substantial doubt exists, additional disclosure is required. This new standard will be effective for the Company for annual and interim periods beginning after December 15, Early adoption is permitted. The Company expects to adopt this new standard for the fiscal year ending December 31, 2016 and the Company will continue to assess the impact on its financial statements. The FASB has issued Accounting Standards Update ( ASU ) No Compensation Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, Early adoption is permitted. The Company is currently evaluating the effect of the ASU on its financial position, results of operations and cash flows. 8

9 4. Cash Segregated for Regulatory Purposes Under Rule 15c3-3 of the Securities Exchange Act of 1934, at June 30, 2016, cash in the amount of $174,000 was segregated in special reserve bank accounts for the exclusive benefit of customers. 5. Deposits with Clearing Organization At June 30, 2016, the Company had deposits with its clearing organizations of $885,000. At June 30, 2016, the required minimum balance was $275,000. The amount was held in an interest bearing account. 6. Fair Value Measurement A description of the valuation methodology applied to the Company s major categories of assets measured at fair value on a recurring basis follows. There have been no changes in the methodology used at June 30, Marketable Securities consist of exchange-traded equity securities valued using quoted market prices. This method may result in a fair value that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes its valuation methodology is appropriate and consistent with industry practice, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date. The following table summarizes the valuation of the Company s financial assets at June 30, 2016: 9

10 7. Equipment and Fixtures LOYAL3 SECURITIES, INC. Equipment and fixtures consist of the following: 8. Payable to Customers Payable to customers consist of free credit balances and securities failed to receive at June 30, 2016, all of which have been outstanding less than 30 days. 9. Regulatory Capital Requirements The Company is a broker-dealer subject to Rule 15c3-1 of the Securities and Exchange Commission ( SEC ), which specifies uniform minimum net capital requirements, as defined, for its registrants. As of June 30, 2016, L3Securities had regulatory net capital, as defined, of $960,000, which exceeded the minimum net capital requirements by $710,000. L3Securities has elected to calculate its net capital under the aggregate indebtedness method, whereby its aggregate indebtedness may not be greater than fifteen times its net capital, as defined. As of June 30, 2016, L3Securities aggregate indebtedness to net capital ratio was 1.44 to Advances to parent, dividend payments and other equity withdrawals by the Company are subject to certain notification and other provisions of the SEC and FINRA rules. In addition, the Company subject to certain notification requirements related to withdrawals of excess net capital. 10. Employee Benefit Plans The Company has a 401(k) defined contribution plan. The 401(k) plan allows eligible employees to contribute up to 15% of their compensation, subject to a statutory prescribed annual limit. Employee contributions and earnings thereon vest immediately. Although the Company may make discretionary contributions to the 401(k) plan, none were made during the six months ended June 30,

11 11. Commitments and Contingencies In connection with its underwriting activities, the Company enters into firm commitments for the purchase of securities in return for a fee. These commitments require the Company to purchase securities at a specified price. Securities underwriting exposes the Company to market and credit risk, primarily in the event that, for any reason, securities purchased by the Company cannot be distributed at anticipated price level. As of June 30, 2016, the Company had no open underwriting commitments. The Company leases its San Francisco corporate office and New York office under noncancelable operating leases that expire in March 2018 and August 2016, respectively. The New York office was closed effective April 30, Concentration and Credit Risk Substantially all of the Company s cash and cash equivalents are held at three major U.S. financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand. At June 30, 2016, amounts due from one client accounted for 100% of the accounts receivable. The Company is also exposed to credit risk as it relates to the collection of receivables from third parties. 12. Financial Instruments, Off-Balance Sheet Arrangements and Indemnification Financial Instruments The Company trades securities that are traded in the United States stock exchanges. As of June 30, 2016, the Company had not entered into any transactions involving financial instruments that would expose the Company to significant related off-balance-sheet risk. Market risk is primarily caused by movements in market prices of the Company s trading and investment account securities. The Company s trading securities and investments are also subject to interest rate volatility. The Company manages market risk through its internal risk management policy and procedures. Off-Balance Sheet Arrangements The Company was not a party to any off-balance sheet arrangements during the six months ended June 30,

12 12. Financial Instruments, Off-Balance Sheet Arrangements and Indemnification (continued) Indemnification The Company places and executes customer orders. The orders are then settled by a clearing organization that maintains custody of customers securities. Through indemnification provisions in agreement with the clearing organization, customer activities may expose the Company to off-balance-sheet credit risk. Financial instruments may have to be purchased or sold at prevailing market prices in the event a customer fails to settle a trade on its original terms or in the event cash and securities in customer accounts are not sufficient to fully cover customer obligations. The Company seeks to control the risks associated with customer activities through customer screening and selection procedures, as well as through requirements on customers to maintain adequate collateral in compliance with various regulations and clearing organization policies. 13. Subsequent Events The Company evaluates subsequent events that have occurred after the balance sheet date but before the financial statements are issued. There are two types of subsequent events: (1) recognized, or those that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements, and (2) non-recognized, or those that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Based on the evaluation, except for the following, the Company did not identify any other recognized subsequent events that would have required adjustment to the financial statements. On July 6, 2016, July 15, 2016, and July 22, 2016, the Parent made capital contributions to the Company in the amounts of $250,000, $150,000, and $700,000, respectively. 12